Impression on International Seminar on Defence Finance and Economics

The recently concluded three-day international seminar on Defence Finance and Economics, organised by the Indian Ministry of Defence (Finance) in New Delhi, covered a wide variety of issues concerning defence finance and economics and reflected on varied perspectives and practices from across the globe. The seminar was of particular importance because of the involvement of policy makers, academics, and other experts from think tanks and the media, in exchanging and discussing their views in the realm of the changing business and spectrum of defence worldwide. The discussion focussed on some pressing issues like defence strategies and economics, optimal resource allocation in defence, myriad dimensions in defence acquisition and offsets, defence research and development, defence manpower issues, audit and accountability in defence expenditure and procurement, and cost efficient logistics management in defence.

Focussing on the importance of economics in defence strategies, experts expressed their views on a range of issues like affordable defence, economics of force designs, trends in global defence industry and military expenditure and some core issues of defence economics. Regarding world military expenditure (US $1,118 billion in 2005, according to SIPRI), experts highlighted the fact that in recent years it has been growing at a faster rate and is approaching peak Cold War levels, motivated by the Global War on Terror (GWOT) and military operations in Afghanistan and Iraq. In the last 10-year period (1996-2005) it has shot up by 34 per cent in real terms. However, while global military expenditure has significantly grown, its distribution has been spatial. Low-income countries spend a higher share of the total on personnel and operating costs, while high-income countries spend on arms procurement and military research and development (R&D). In addition, the world arms industry is growing at a faster pace. The SIPRI top 100 arms-producing companies together accounted for $268 billion worth of armaments sales in 2004, a marked growth of 15 per cent over the previous year. With such growth, there have been structural, technological and compositional changes in the arms production industries.

Optimal allocation in the defence sector, another area of discussion, has always been a major challenge for planners. In the 21st century, the challenge has been accentuated by the cut in the defence budget (except in the case of a few countries) in real terms, the extreme capital- and cost-intensive nature of modern war equipment, and by the concept of RMA and Net Centric Warfare. Against this backdrop, proper budgeting, planning and portfolio analysis in defence has become more relevant. As some cross-country evidence shows, the principle of sound allocation of resources for defence is based on identification and probability of risk factor; concept of force design and its costing including the full life cycle costs, and finally optimising measures. Besides, other efficiency measures like outsourcing, project management, management information, use of civilians in defence departments, management and leadership are in use.

Defence acquisition, according to many experts, is a complex and difficult business and holds critical importance because of vulnerability to fraud, waste, and mismanagement. Best practices around the world show that the modern system of acquisition should be more responsive, efficient and effective, i.e., faster, better and cheaper, while focussing on certain achievable outcomes. The effects of competition, life cycle cost considerations, legislative barriers, contract provisions – all need to be examined to get better value for money. Defence offsets, which is being increasingly used by arms buying countries, has become an instrument to leverage the outflow of foreign currencies to supplier countries. While it has placed added pressure on the supply side to oblige the offset obligations, it has also resulted in increased cost of equipment though with no significant benefits for the purchasing countries. Besides, there are many other weaknesses in implementing and over-sighting the whole procedure, which renders the whole policy of little value. Some experts opined that offsets do not promote countries’ long-term military industrial goals and does not stimulate broad-based economic development. Moreover, neither substantial nor sustained job creation occurs and only little technology transfer occurs and whatever technology is transferred is quickly outpaced by continuous technology advances in the main supplying countries. However, the ingredients of a successful offset policy warrant a relatively advanced domestic industry to absorb and capitalise on benefits of offsets and with this clear oversight and audit mechanisms are necessary to systematically monitor progress and continuously revamp weaknesses.

Military defence research and development (R&D) expenditure and its interface with those of the civilian sector is a highly contested issue. Panellists demonstrated through statistics that in recent years greater weight is being assigned to more defence R&D expenditures. Statistics also reveal that in the four-year period 2000-2004 global military expenditure grew by 23 per cent to total $85 billion, representing 10 per cent of the total (civilian and military) R&D expenditure worldwide. Factors that led to increased defence R&D expenditure are: the evolution of the RMA into the concept of Network Centric Warfare; the increased need for exceptionally good intelligence capabilities and new set of weapons suitable for global warfare and urban warfare; and the need for commercialising defence technologies through new and improved versions of equipment. However, there exists a huge gulf in defence R&D expenditures between the US and European countries, which has lately resulted in some controversies over the competitiveness of European defence and commercial technologies and on the impact on the transatlantic relationship.

Regarding military manpower, analysts expressed its importance as a vital input in the overall military production function. In the present strategic military environment, its importance has gone up manifold, requiring a skilled, entrepreneurial force level, finely tailored, more accessible to joint operations and better configured to operate with other agencies and international partners. But at the same time, the cost of maintaining a large conventional force and the technology-driven substitution effect has taken centre stage in the military planning process, resulting in rebalancing between active and reserve forces, military to civilian conversions, unified command, etc.

Another crucial aspect is related to defence logistics, the cost of which is around one-fourth of the total defence budget. While no one discounts the importance of this aspect, however, defence capability and its adaptability to future needs depends much on how efficiently this is managed. An efficient management of logistics, as some international practices show, requires performance-based system, where the suppliers are paid fee-per-usage basis instead of paying individually for ‘bundled’ support systems. For the cost-efficient management of logistics, best practices in the private sector – centralised management and strategic sourcing – can be applied.

In the session on Audit and Accountability, the issue that came to the fore was obtaining the best value for money, the supreme auditing offices of many countries resorting to different forms of auditing to see the legality of expenditure, compliance to rules and their propriety. More importantly, audit institutions also carry out performance audit, or value-for-money audit, to see the efficiency and effectiveness of expenditures. The suggestions/findings of these auditors form the basis on which the respective defence planners and political executives are made accountable. However international evidence, especially those of GAO (USA), OAG (Canada), or CAG of India, shows that defence auditing is not fully followed by necessary accountability. The common shortcomings identified by all these supreme auditors could be attributed to the lack of professionalism in dealing with various aspects of defence management, leading to cost and time overruns. Besides, evidence also shows that most defence departments are manned by birds of passage, and personnel are neither properly trained nor retained for a minimum required period to see the contracts through. Moreover, the absence of legal, technical and financial experts has led to cost and time overruns. Participants voiced the need for greater dialogue among auditors, defence managers, defence personnel and executives.

In the light of above discussions, the international seminar holds special importance for India given that since the beginning of economics reforms in the early nineties, the urgency of fiscal management and better utilisation of budget was strongly felt across the spectrum of economic and non-economic activities. The staggering increase in the Indian defence expenditure (Rs. 89,000 Crore or 2.52 per cent of GDPMP in 2006-07) necessitates the need to ponder over affordability, sustainability and its impact on overall fiscal management and economic development, while not compromising the security apparatus of the country, which has been aggravated by new concerns over asymmetric and non-conventional warfare. Defence has long been left out of rigorous economic analysis because of the ‘holy cow’ approach as well as due to notions like strategic concerns, absolute state power, etc. These notions have led the country to mess up defence resources. Be it cost-ineffective Qualitative Requirements (QRs), or obtaining greater output/capability, economic aspects have long been sidelined. The seminar itself was a welcome step in the much-neglected field of defence finance and economics in India. The rich knowledge generated during the course of the seminar, if applied by the Ministry of Defence and other stakeholders, could better India’s planning, execution and management of defence.